If small firms go under only big cats will survive

In the IT jungle users putting the bite on suppliers may pay a high price for small savings, as they speed the evolution of a super-predator. Julia Vowler reports.

Schadenfreude is never an admirable quality, though sometimes it is understandable. But if IT directors are taking any covert pleasure in the latest round of profit warnings and grim revenue postings from IT suppliers to whose coffers they have contributed so generously in the past, they should think again.

If money spent is money earned, then money saved by one company means lower revenues for the next in line in the food chain.

Gary Kelly, technology equity analyst at Barclay Private Clients, says IT directors are under pressure not to spend their budgets. "It's pretty grim," says Kelly. "The biggest issue for technology stocks is that corporate profitability is still weak, so companies don't spend on IT infrastructure."

But what kind of knock-back effect will this spending freeze have on their customers, the IT departments? The obvious consequence is that the cost of IT should fall as suppliers accept lower margins. The survey of 300 European chief information officers by Merrill Lynch, for example, finds evidence of this in IT services.

More than half (58%) of the chief information officers questioned have managed to "extract price reductions from their IT service providers" this year, says the survey, with 40% achieving more than 10% cuts, while 11% persuaded suppliers to cut more than 25%. French and UK chief information officers are the most adept at winning reductions for IT services, finds Merrill Lynch.

But while it is tempting to assume that recession creates a buyers' market that can only be a good thing for customers, it can also be dangerous if the supplier community becomes too weak. Like predators and prey, there needs to be a sustainable balance in the respective populations. Should you, then, support your key suppliers?

Although no automatic loyalty to suppliers is due, IT directors should keep an eye on key suppliers, says Kelly. "You don't want your technology to be defunct because the company is no longer in business."

Julian Hewitt, chief analyst at Ovum, says, "The financial health of your suppliers is more important than ever."

With 1,000 of the technology companies assessed in Ovum-Holway research losing money - "If you add up all the profits recorded by all 2,000 companies it's negative," Hewitt adds - IT directors need to monitor their supplier portfolio carefully. "They need to spread their risk and have alternative sources of supply," he says.

Assessing risk accurately may not be a straightforward matter - in the post-Enron era how much confidence can customers have in the financial reports or the management of their suppliers? For example, a troubled telecoms supplier may not be visibly losing customers, but it could be losing traffic - and revenue, Hewitt points out.

A recession-driven supplier shake-out can cut customer choice. Companies that survive might be over-mighty when growth takes off again (or over-mightier - Microsoft is protecting future revenues by imposing its new licensing regime on users even during a recession).

So as they cut their own spending and channel what they do have into the safer waters of the larger suppliers, heads of IT should expect increasing polarisation of the IT market - the big and strong will fare the best.

"Investors are sticking to winners," Kelly says. "The bigger companies are gaining investment at the expense of smaller ones because the biggest names, such as IBM, Microsoft and Oracle, support higher valuations."

What investors like most about a technology supplier is its good, old-fashioned bottom line, not its great technology. In hard times, even smaller players with great technology will find it difficult to survive, squeezed both by their customers' enforced thrift and investors' caution.

"They have reduced access to capital and debt markets," says Kelly. This makes them more attractive to big suppliers that can afford to start taking their places whenever the good times return.

"The likes of IBM and Microsoft are well placed to snap up smaller players as their valuations collapse," says Kelly. "Microsoft has a very robust balance sheet and is in a fantastic position to buy the next generation of technology at low prices."

But corporate IT will emerge from recession to discover that a lot of exciting new technology they have had their eyes on but have not had the budgets or business reasons to buy has now found its way into the pockets of the big five suppliers. The pool of suppliers from which to buy IT will have shrunk even more with the disappearance of some established names that are looking increasingly shaky.

Naming names is always contentious, but Kelly predicts, "We will see a couple of high-level technology companies go bust," putting warning signs over both Ericsson and France Telecom - telcos are particularly vulnerable. "The wireline market is a complete disaster," he says, "though wireless is holding up better than anticipated."

In computing, chary users want to see more return on investment. "They want to see absolute benefit," says Kelly. This could be particularly true in areas such as customer relationship management, where the Merrill Lynch survey shows that post-hype disillusion means that only 36% of respondents have a CRM system, and 83% of those that do not have no intention of getting one in the next 12 months.

Even outsourcing, which can be even more tempting in a recession, is only tempting if the cost is compelling, says Kelly. "Margins are wafer thin, and the cost of a contract to the outsourcer is hard to predict," he says.

Recession always takes a bitter toll of all except out-placement consultants and liquidators, but IT directors should remember that the supplier-user relationship is never straightforward.

Nature teaches us that famine means that predators go hungry as well as prey. In IT, it is not always clear just who is predator or who is prey when the hunters become the hunted.

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